Xilinx: A global disruptor that’s pure logic

The maker of programmable logic devices used in mobiles and other products has huge upside, and a recent price drop presents a good opportunity.

Summary: Xilinx is the world’s largest supplier of programmable logic devices, used in everything from mobiles to cars and military applications, with a global market share of around 50%. The company has huge upside, however a recent downgrade in its earnings and revenue guidance has spurred a share price fall.
Key take-out: Xilinx is a Buy with a target price of $US51 or 18x CY (calendar year) 2015 earnings of $2.85. The stock will probably consolidate in the high $US30s and low $US40s.
Key beneficiaries: General investors. Category: International shares.
Recommendation: Buy Price at call: $US41.06 Target price: $US51 Risk: Medium

In the McKinsey Global Institute study (“Disruptive Technologies: Advances that will transform life, business, and the global economy”) discussed in last week’s Eureka Report, mobile internet was predicted to have one of the largest contributions to global GDP over the next 10 years.

McKinsey estimates that the mobile internet could generate a measurable global economic impact of some $US3.7 to $US10.8 trillion per year by 2025. Over half of that will come from the developing world, as more than 3 billion people eventually become connected.

Now for us this is not really a new theme as smartphones, tablets and other devices are now ubiquitous in the developed world, with over 1 billion people using the devices. Money has been made investing in hardware suppliers such as Apple, Samsung, LG, and HTC, not to mention their component manufacturers / assemblers and software developers. This space is getting a bit crowded, with competition rife and little pricing power. However, given the size and scope of the mobile internet phenomenon there are still lots of opportunities.

In order for the mobile internet to continue to deliver products and services to the world at large, it will need faster and more efficient networks. As new 4G wireless networks are built out over the next few years in both the developed and developing world (especially China), companies that are providing the underlying technology and infrastructure should do well. I believe Xilinx (NASDAQ:XLNX), a US-based manufacturer of programmable logic devices used extensively in the telecommunications industry is well placed to benefit over the medium and long term.

Generating $US1.8 billion of revenues in 2013, Xilinx is the world’s largest supplier of programmable logic devices (PLDs), which are essentially integrated circuits (ICs) that can be programmed by the end user for specific functions such as device to device interfacing, signal processing, data display and control operations. With the ability to program their own chips, customers realise two key benefits: product design flexibility and faster time to market.

Given today's shorter product lifecycles, both of these factors can be critical determinants of a product's ultimate success. Xilinx’ end markets are primarily in communications and networking, but there are industrial, military, and consumer applications as well. See below:

Table 1

Market Segment

Market Sub-Segment

Application / Product

TELECOM AND WIRELESS

TELECOM


WIRELESS

  • Access Systems
  • Metropolitan Area Networks
  • Optical Networks
  • Cellular Base stations
  • Wireless Local Area Networks (LANs)

AUTOMOTIVE, INDUSTRIAL
AUTOMATION AND MILITARY

AUTOMOTIVE

INDUSTRIAL AUTOMATION



MILITARY

  • Car Entertainment Systems
  • Navigation Systems
  • Card Readers
  • Energy Management Systems
  • Manufacturing Equipment
  • Surveillance Systems
  • Guidance and Control Systems
  • Radar Systems
  • Secure Communications Systems

NETWORKING, COMPUTER AND
STORAGE

NETWORKING

COMPUTER

OFFICE AUTOMATION


STORAGE

  • Routers
  • Switches
  • Mainframes
  • Servers
  • Copiers
  • Multi-Function Peripherals
  • Printers
  • Redundant Array of Inexpensive Disks (RAID) Systems
  • Storage Area Networks (SANs)

OTHER

MEDICAL

TEST & MEASUREMENT


BROADCAST


ENTERTAINMENT

  • Medical Imaging & Diagnostic Systems
  • Patient Monitoring Systems
  • Communications Test Equipment
  • Oscilloscopes
  • Semiconductor Test Equipment
  • Broadcasting Equipment
  • Studio Editing Equipment
  • Satellite Equipment
  • Cable Set-Top Boxes
  • Flat-Panel Televisions

Xilinx derives almost 50% of revenues from the communications segment, 34% from industrial / aerospace and some 15% from consumer and automotive. The company is global in scope, with 44% of its business coming from Asia, 34% from North America, and 21% from Europe. It is the communications segment and its Asian-centred business that is expected to strongly drive revenues and earnings going forward.

The investment case for Xilinx

Xilinx is predicted to strongly participate in the LTE / 4G network build-out currently underway in China, the US and Europe.

Higher revenues and improvements in manufacturing costs should propel margins to new highs and over $3 per share in earnings power.

Finally, Xilinx’s strategic position in new products is strong almost unassailable at this point of time. Xilinx is months ahead of competitors as device gate lengths shrink from 28 nm (nanometers) through 20 nm to 16 nm. Xilinx’s main competitor is Altera and together they control 80% of the market. Barriers to entry are so high in this specific industry that the other players only operate in smaller market segments.

China remains the biggest opportunity for Xilinx in the second-half of 2014 and 2015, with China Mobile set to deploy 500,000 base stations, China Telecom 145,000, and China Unicom planning to cover 300 cities. Just 25% of the projected network is complete and JPM Morgan Asia analysts estimate an overall base station population of 1.5 million by 2016. Xilinx is the dominant player in China, with a 70% market share in base stations.

China is not the only story, as European carriers Telefonica, Orange SA and Vodafone have also flagged an increasing LTE / 4G spend. In the US the major carriers Sprint and T-Mobile continue to aggressively build out their networks to try and keep up with the increasing power of smartphones and proliferation of digital data.

I expect Xilinx’s gross margins to approach 70% over the next fiscal year. (The company’s guidance is 68-70%). A better product mix (more 28nm, less 45nm and 69nm product) should underpin overall profitability as well as continued operating efficiencies from TSMC (Taiwan Semiconductor Manufacturing), its foundry partner, and a strong focus on operating costs. That Xilinx is “fabless” (it has outsourced the product manufacturing) is a distinct advantage in that it doesn’t need a huge capex budget to upgrade factories and allows it to focus on design, research and development.

Xilinx is extremely well placed with its current and upcoming product suite versus the competition. Altera, a similar company, is well behind at the 28nm node generating only $US57 million in revenues in Q1 2014. Xilinx generated $US140 million in the same period. Xilinx is already shipping at the 20nm level and developing the 16nm product months ahead of Altera.

June Quarter Results

On July 23, Xilinx reported its results for the June quarter. There was a slight beat on earnings ($US63c vs consensus of $US62c), gross margins came in at an impressive 69.1% but revenues were a bit light ($US613 million vs. previous guidance of $US618 million) and guidance was (as usual) “conservative” with a prediction of a slight deceleration of revenue growth into the September quarter (-4%).

The company also lowered its revenue growth projections for its FY15 (Xilinx FY is April to April) from 10% to 5%. Management sees some softness in LTE / 4G over the next 1-2 quarters but with resuming momentum in 2H FY15 (the December quarter) and also noted its 65nm and 40nm products in markets other than China offset some of the slack. Its other businesses, industrial and consumer (the other 50% of revenues), were stable meeting consensus expectations. After the earnings release and conference call the stock fell sharply – down 14% on the next trading day – and has created what I believe is an extreme overreaction and hence an excellent buying opportunity for long-term oriented investors.


Conclusion

Investing in growth stocks requires patience and looking through the market noise. To me the market has overreacted here. Why? Well, in the first place, component orders from Chinese telecoms in my experience are never going to be linear. The telcos have their own build-out schedule and from time to time will order an excess of componentry in case of shortages. This appears to be what has happened here. It’s an inventory problem which will be worked out over the next few quarters.

Secondly, investors must ask the question “will the projected build-out never happen, be diminished or delayed indefinitely?” That’s unlikely, considering the incredible proliferation of data hungry tablets and smartphones in China going forward and the necessity for faster and more advanced networks. For example, shipments of LTE-equipped phones in China surged to 31 million units from only about 10 million in the first quarter of 2014, according to the China Academy of Telecommunications Research.

Xilinx is a BUY with a target price of $US51 or 18x CY (calendar year) 2015 earnings of $2.85. The stock will probably consolidate in the high $US30s and low $US40s and I would be buying at these levels.

Risks

  • Unexpected spending declines or postponements from major carriers. 
  • Continued macroeconomic weakness in Europe.
  • Altera catches up at 28nm and surpasses at 20nm and 16nm.

Financials

Price & Volume

Recent Price $

41.79

52 Week High $

55.59

52 Week Low $

42.84

Average Vol (Mil) (RTMA)

2.83

Beta

1.57

Share Related Items

Market Cap. (Mil) $

11069.9

Shares Out (Mil)

268.79

Float (Mil)

267.81

Dividend Information

Yield %

2.80

Annual Dividend

1.16

Payout Ratio (TTM) %

46.00

Financial Strength

Quick Ratio (MRQ)

2.80

Current Ratio (MRQ)

3.10

LT Debt/Equity (MRQ) %

36.00

Total Debt/Equity (MRQ) %

57.00

Valuation Ratios

Price/Earnings (TTM)

22.10

Price/Sales (TTM)

5.46

Price/Book (MRQ)

4.73

Price/Cash Flow (TTM)

18.00

Per Share Data

Earnings (TTM) $

2.19

Sales (TTM) $

8.86

Book Value (MRQ) $

10.25

Cash Flow (TTM) $

2.69

Cash (MRQ) $

3.62

Mgmt Effectiveness

Return on Equity (TTM)

22.90

Return on Assets (TTM)

12.50

Return on Investment (TTM)

16.80

Profitability

Gross Margin (TTM) %

72.20

EBIT Margin (TTM) %

32.00

Net Profit Margin (TTM) %

26.50


(Source Xilinx website July 24, 2014)

Mil = Millions  RTMA = Rolling Three Month Average
TTM = Trailing Twelve Months  MRQ = Most Recent Quarter
Pricing and volume data as of Jul 24, 2014

To read Xilinx Inc’s Forecasts and Financial Summary, click here.

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